High-Frequency Traders Catch a Break in EU Market-Making Rules

  • Regulations seek to ensure market making is more stable
  • Venues aren't required to give incentives for some assets

High-frequency traders just caught a break in Europe, where it’s now easier to escape stricter rules for market makers.

European Union regulators on Monday revised proposals for overhauling the 28-nation club’s financial markets. For traders, there’s a change from their previous plans: You’re not considered a market maker -- and therefore subject to new obligations -- until you’re supplying bids and offers for a given stock or financial product for half the trading day. Before, the threshold was only 30 percent of the day.

On major exchanges around the world, high-frequency traders are among the dominant suppliers of liquidity -- the role played by traditional market makers. They have, however, faced criticism that they don’t stick around during times of turmoil, potentially exacerbating losses for others. The European rules are aimed at easing that concern by making high-speed firms more accountable.

On Monday, the European Securities and Markets Authority diluted the regulations, reacting to criticism that trading firms with no intention of being market makers could inadvertently be swept up by the rules, prompting them to stop trading an asset or to flee exchanges altogether. Another worry is that the administrative burden could drive some companies out of the market, further reducing trading.

‘Scared Off’

“Pretty much all of our members are market makers, but they may not be market makers in all asset classes,” said Johannah Ladd, secretary general of the FIA European Principal Traders Association in Amsterdam. “You don’t want to scare them off from providing liquidity in asset classes that aren’t their core focus.”

Another dilution to the standards is that a firm must trade an instrument for 50 percent of the trading day for half a month, rather than a single day, in order to be labeled a market maker.

The regulations try to make market making more stable in part through a written agreement with the trading venue, in which the two sides agree on the trading firm’s obligations as well as incentives such as rebates in return for trading. The information must be publicly disclosed. Market makers must provide “competitive prices” for at least half the trading day, according to the rules.

‘Exceptional Circumstances’

Market makers can still pull away during “exceptional circumstances,” which are up to the trading venues to determine.

It’s not clear the repercussion of violating the rules. Market-making enforcement is left up to trading venues, which are supposed to ensure the rules are enforced and to monitor for compliance. The competent authorities, such as national regulators, have the power to enforce the rules.

The proposals didn’t completely satisfy everyone. Trading venues including stock exchanges are required to provide incentives to market makers in more heavily traded instruments including equities and exchange-traded funds, but some assets like interest-rate options, aren’t included. That means a venue could set obligations for a market maker without providing incentives.

“It looks like the rules are asking market makers to commit to taking on risk in all asset classes without offering, in all cases, incentives to do so,” Ladd said. “That’s not a sustainable business model.”

The standards will take effect in January 2017 unless one of the EU’s main institutions -- the European Commission, the European Parliament or the Council of Europe -- objects to ESMA’s drafting of the rules.

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